Investing Blog

What crowdfunding rules mean for you

The regulatory wheels are turning at the Securities and Exchange Commission, where proposed rules on equity crowdfunding were released Wednesday. But don't expect to be a venture capitalist anytime soon.

The JOBS Act, or Jumpstart Our Business Startups, was signed in April 2012. It mandated that the SEC figure out some way to let investors buy equity in small businesses and startup companies -- no small feat considering the number of pieces that have to fit together before the equity crowdfunding market can get up and running. Plus, crowdfunding in general is a vastly different vehicle from the registered investments the SEC normally oversees.

"It's a sea change; they're crafting a fairly balanced and fair approach given the legislation they were offered. On first reading, it seems like the commission has really tried to enact rules that will make crowdfunding effective," says Richard Swart, director of research for the Innovation in Entrepreneurial and Social Finance Program at the University of California, Berkeley.

Very generally there are three components to the proposed rules: rules for investors, rules for businesses and rules for funding portals -- the platforms through which the crowdfunding transactions will actually take place.

Here's an overview of what investors can look forward to with respect to limitations and the kind of disclosure they'll get from potential investments.

For investors:

Over a 12-month period, in individual investments, investors will be able to invest up to $2,000 or 5 percent of their annual income or net worth, whichever is greater.

Investors with a net income or net worth of more than $100,000 will be able to invest up to 10 percent of their annual income.

There will be restrictions on resales and transfers. Investors will have to hold securities for one year.

For businesses:

The level of financial disclosure required of businesses will depend on the amount of money they're trying to get. Companies will be exempt from registering securities with the SEC as long as the amount raised is less than $1 million and therefore eligible for crowdfunding.

Under the proposed rule, companies raising more than $500,000 would have to provide audited financial statements. Issues between $100,000 and $500,000 will be required to provide investors with financial statements reviewed by an independent public accountant.

For less than $100,000, companies will need to furnish tax returns for the most recent year and financial statements certified by the principal officer of the company.

More details of the offering will be required as well, including the price, how much they hope to raise and the deadline for funding.

"The reporting requirements are going to be a cost of raising capital. It's not going to be seamless and without cost. There are the financial auditing requirements and an explanation of the valuation methodology, which are kind of unusual, so I think you'll see an industry emerge to managing investor relations for small businesses," says Swart.

Swart believes that the existing framework may be relaxed in several years.

Time to get excited?

The SEC is still soliciting comments on the proposed rules. Comments will be taken for 90 days from the proposal's publication in the Federal Register. After that, the commission will review everything and maybe make changes.

"The most optimistic scenario is that we're six months away from equity-crowdfunding for non-accredited investors to go live in the U.S.," says Swart.

People hoping to get in on the ground floor of high-tech growth companies might be a little disappointed. While those will be among the companies vying for investor dollars, Main Street businesses may be more likely to turn to crowdfunding for an infusion of capital.

"You're going to see businesses with established customer bases that have relationships that are already in place but have a hard time getting bank financing due to restricted lending markets right now," Swart says.

Impact investors -- do-good types who want to invest in innovative, community-changing projects -- should be excited. "There's a strong tie between community projects, social entrepreneurship and crowdfunding due to the roots in the creative and art space. Social impact investors will find a lot of interesting projects," according to Swart.

Expect niche platforms to proliferate as well. "Investors with a particular interest area may be able to find sites that curate deals that match their interests," says Swart.

What do you think about equity crowdfunding? Do you think it will spur more entrepreneurs to get into business? Will you be interested in investing in a small business?

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